Economic Update - June 2015
Domestic Equities
The S&P/ASX 200 Accumulation Index suffered its largest monthly
decline since September 2014, ending June down 5.3% (-5.5%
price). The index opened the month with consecutive periods of
price falls before regaining its footing in the latter half, only to sell off
again as fears surrounding Greece’s debt drama heightened. The
Reserve Bank of Australia left the cash rate unchanged in June at
2%. The central bank noted that although the AUD had declined
significantly against the USD over the past year, the depreciation
was less pronounced against a basket of other currencies. The RBA
stated that further depreciation seemed “both likely and necessary”
though no real guidance as to future rate decisions was provided.
Instead, the central bank has chosen to go with a data-driven
approach. The AUD ended the month largely unchanged versus the
greenback (+0.8%) and on a trade-weighted basis (+0.2%) during
June. Unemployment fell unexpectedly to 5.96% during May while
participation rate held steady at 64.7%. At a sector level, Consumer
Discretionary stocks were the key detractor, down 11.2% on an
accumulation basis, followed by the mining-heavy Materials sector
(-8.3%, acc). Outperformers included Telcos (-1.3%), Banks (-2.3%)
and REITs (-4.1%).
The outlook for the Australian equity market continues to remain
challenging. However, Australia’s ranking improved verses its peer
group. Commodity prices, while stablising, still lack any catalyst for
a significant turnaround. China’s focus continues to be on monetary
rather than fiscal stimulus with another welcomed rate cut in June
against a weakening property and share market. Warren Buffet’s
strategic investment in Insurance Australia Group (IAG) lifted the
mood for financials but this was offset against the continued battle
banks are having with the regulator about regulations as well as
ongoing concerns about a housing bubble.
International Equities
Monthly Local
Currency Returns
Monthly Unhedged
(AUD) Returns
MSCI USA
-1.9%
-2.3%
MSCI EAFE
-4.4%
-3.2%
MSCI Emerging
Markets Index
-2.2%
-2.9%
MSCI World ex
Australia
-2.8%
-2.6%
Sector
Source: Factset, MSCI. Index returns are unmanaged and do not reflect the deduction of any fees
or expenses. The index returns reflect all items of income, gain and loss and the reinvestment of
dividends and other income. Past performance is not indicative of future results.
Global markets in June were unsettled by a steady stream of
worrying headlines from Europe as increasingly acrimonious
negotiations between Greece and the Troika (European Commission,
European Central Bank and International Monetary Fund) to extend
an existing bailout agreement came to an impasse. Developed equity
markets posted generally disappointing results for the month, with
MSCI World ex Australia down 2.6% in AUD terms (-2.8% local).
U.S. Large Cap Indices continued to trade in a tight range in June
with the S&P 500 hitting a high of 2124.2 on June 23rd for the
month and a low of 2057.6 on June 29th, a mere 3.2% spread.
1 | Economic Update - June 2015
For all of 2015 in fact the US market as gauged by the S&P 500
Index has been extremely tentative in direction, never up more than
3.5% or down more than 3.2% during the first six months of 2015,
the tightest mid-year trading range on record. For the month, the
S&P Total Return Index finished the month down 1.9% (local). On
June 17th, the Federal Reserve provided an update of the ‘dot’ plot
indicating where members of the Federal Reserve Board anticipate
the Federal Funds rate to be looking forward. As was true from the
prior March dot plot, the median response of members was that
there would likely be two interest rate increases by the end of 2015,
still higher than the market expectation priced in the futures markets.
While the world continues to read the tea leaves for when the Fed will
move, China’s central bank announced a surprise rate cut on June
27th. This move was widely viewed as a response to a precipitous
fall in China’s roaring stock market, but it should be noted that the
People’s Bank of China has been steadily easing monetary policy
since late in 2014 having reduced their policy lending rate by more
than 100 basis points and required reserves by 150 basis points.
After rising 153% on a rolling one year basis through June 12, the
Shanghai Stock Exchange Composite Index declined 19% through
June 26th. The Chinese market has been viewed as particularly
vulnerable given the rapid run up in shares driven in part by retail
margin buying. The recent volatility may limit the prompt inclusion of
China’s A shares in the MSCI emerging markets index that had been
widely anticipated.
As the month came to a close, markets were again rattled by
questions over Greece’s sustainability within the Eurozone, driving
the Euro Stoxx 50 implied volatility sharply higher and taking the
equity implied volatility component as a whole into a Crisis regime
reading to end the month.
Japan’s model score was largely unchanged since last month. The
score remains solid and the QE/stimulus program remains in place.
Sentiment was the largest contributor, followed by momentum, with
value the largest detractor. GDP was revised sharply upwards and
exports strong, but demand and lack of inflation are still a concern.The potential for more stimulus as we await impact of structural
reform remains (Abe is trying to shift the focus towards capital
investment in the advance technology sector).
Europe remains favoured by the model holding 9 out of the top 10
spots. Eurozone countries were clearly favoured vs ex-Eurozone.
Lower oil prices and steady global growth are also supporting the
European economy. Key risks however remain on Greece and later
in the year, there will be increasing uncertainties arising from the
different elections lined up in Spain.
Domestic Fixed Income
The domestic bond market steepened significantly in June, as the
short end remained well bid as the RBA maintained its easing bias
while the long end rose 28bps to 3.01% in response to the global
sell off.
Economic Update - June 2015
The performance of the domestic economy remains subdued. While
the housing sector remains strong there have been recent signs that
the rate of price increases has declined. While the May employment
number surprised to the upside, with the unemployment rate falling
to 6%, recent business surveys suggest employment growth may
remain subdued over the medium term. The RBA would also be
concerned about weak consumer sentiment indicated by recent
soft returns in both retail sales and private sector credit growth.
When this picture is added to the weak outlook for business capital
expenditure it is difficult to see the RBA giving up its easing bias
especially in light of the current uncertainty experienced in offshore
markets.
Looking ahead, we see less value in short duration Australian Fixed
Income assets verses Global Equities or USD denominated fixed
income, which we think will benefit from the USD strength. The
Australian bond market remains linked to the rate cycle and the
outlook for yields has improved from our models as well as from
recent comments from the RBA. While the RBA maintained a 2%
cash rate the accompanying statement said that “policy needs to be
accommodative” and that “further depreciation seems both likely and
necessary” for the currency.
Later in the month, investor attention turned to Greece where early
confidence for a positive outcome regarding the Greek bailout
extension began to fade. Initially, markets experienced a solid hit
of de-risking with significant falls in equities and a strong rally in
safe haven bond markets such as the US, UK and Germany with
peripheral spreads moving wider. However, with no agreement
in sight and uncertainty over the ECB’s response, bond markets
experienced a sharp increase in illiquidity as buyers opted out of the
market resulting in a spike higher in yields across the region.
A positive outcome regarding
the Greek bailout extention
began to fade.
International Fixed Income
June was a difficult month for global bond investors as markets
experienced not only a broad increase in yields but also a general
steepening in the curves themselves. The general move higher in
yields was initially driven by solid US data and some unexpectedly
dovish comments made by the ECB President. It was only later in
the month when comments by Fed Chair Yellen, concerns about
the likelihood of a successful Greek bailout extension and questions
about the Chinese economy that markets ran into some profit taking
and bond yields regained some lost ground. However, the rally was
short lived as liquidity issues raised by the lack of a positive outcome
in Greek bailout extension issue saw yields push higher into the end
of the month.
In the US, while the unemployment rate ticked higher to 5.5% (from
5.4%), the economy did add 280k jobs during May suggesting to the
market that a September Fed rate hike was still a distinct possibility.
This view was supported by improved consumer demand (retail sales
+1.2%) and stronger consumer sentiment numbers contained in the
latest University of Michigan Consumer survey. The FOMC meeting
on the 18th June did see some investors look to take profit on short
positions as FED Chair Yellen revealed in the subsequent press
conference that the total trajectory of the Fed funds rate was more
important than the date of the first move, sending a slightly more
dovish message about future Fed moves than the market expected.
In Europe, the main focus for investors was firstly Germany with
Greece taking centre stage later in the month. Early in the month,
the markets were unimpressed with comments from ECB President
Draghi suggesting they should “get used” to increased volatility in
an era of ultra-low interest rates. The market had been hoping for
commentary that would help ease volatility, so these comments,
suggesting the ECB was fairly relaxed about higher bond yields, led
to further selling pressure.
2 | Economic Update - June 2015
Looking ahead, our Fixed Income Sector Rotation models continue
to forecast a rise in both rates and spreads. The Fed rate hike
forecasts have shifted on changing data and risk profile, although
fundamentally, we feel the chance of September rate hike as less
probable. With the exception of GDP to bond yield gap, all factors
in the model were supporting higher level factors while slope factors
still weigh towards flatter curve. After moving from long duration to
neutral duration last month, the model now favours shorter than the
benchmark duration stance. Currency risk however, remains key
from the local perspective.
Domestic Property
Index
Monthly Returns (AUD)
ASX 200 Property Accum
-4.1%
ASX 200 Accum
-5.3%
Source: Factset, S&P/ASX. Index returns are unmanaged and do not reflect the deduction of any
fees or expenses. The index returns reflect all items of income, gain and loss and the reinvestment
of dividends and other income. Past performance is not indicative of future results.
A-REITs (S&P/ASX 200 Property Acc) returned -4.1% in June,
outperforming the broader market (S&P/ASX 200 Acc) which
returned -5.3%. The month was characterised by high levels of
market volatility, and A-REITs have had to contend with concerns
relating to macro policy restrictions designed to slow the expansion
of investor mortgage books implemented in May. Despite this, the
Australia’s residential market showed no signs of slowing in June,
with Sydney dwelling prices up 2.8% during the month and 16.2%
yoy. Foreign investment flows remained strong, with offshore buyers
snapping up 60% of all development sites in the 12 months to April
2015. At a stock level, the top performers during the month were
National Storage REIT (NSR +9.1%), Growthpoint Properties (GOZ
+4.5%) and SCA Property Group (SCP +1.3%).
Economic Update - June 2015
On the other hand, worst performers were Dexus Property Group
(DXS -6.2%), Westfield Corporation (WFD -5.8%) and Mirvac Group
(MGR -5.5%).
Our outlook on A-REITs remains positive. The asset class continues
to be in high demand for investors seeking income and the current
interest rate environment should continue to be a positive for the
asset class. Unlike the US, Australia is in the midst of a cutting cycle
with the market pricing in two more rate cuts. The current global
direction of central banks, except the US, will continue to support
assets with strong yielding characteristics.
International Property
As volatility swept global markets in June, the Dow Jones Global
Select RESI Index returned -4.1% (AUD terms). Across the major
markets, UK and Continental Europe were the best performers
year to date, while US REITs lagged (in local currency terms). Hong
Kong outperformed the global real estate universe in June, where
the undersupplied market has proven resilient to macro prudential
policies. Performance was also supported by record high residential
rents (+2.4% YTD) and high demand for new residential project
launches. The Japanese market underperformed global peers in
June returning -5.2% (local). While broader Japanese equity market
has been busy announcing buybacks, increasing dividends pay-out
ratios and focusing on improving ROE, there was a notable lack of
value accretive corporate actions in the Japanese REIT space during
the month. Europe ex-UK returned -5% (local), this was unsurprising
given the volatility in European equity throughout June, driven primarily
by uncertainty over Greece. US REIT continued to lose ground during
the month returning -4.4% (local) and -6.1% YTD (local).
Alternatives (Commodities)
Spot Brent crude ended June down 4.0%, posting a second month
of declines. Despite gaining 10% in the calendar year to date, the
commodity has lost 45.3% over FY15. Benchmark spot iron ore
prices ended the month down 4.0% after two months of gains in April
and May. During the month, Australia’s Federal Department of Industry
and Science cut its price forecast for iron ore in 2015 by ~10% to
US$54.40/t, citing a weak outlook for China's steel sector. Base
metals as measured by the LME index ended the month down 4.9%.
Tin was the worst performer (-10.6%) followed by lead (-9.8%), zinc
(-8.5%) and nickel (-5.2%). Copper (-4.2%) and aluminium (-2.9%)
were the best performers. Spot gold ended the month down 1.5%
despite ongoing uncertainty surrounding the possibility of a Greek exit
from the Eurozone.
Cash
The RBA maintained an official cash rate of 2.00% in June.
As the majority of both economists and market participants
anticipated, the RBA left rates unchanged at the June RBA board
meeting. Governor Stevens referenced the Australian dollar again
and determined that a lower AUD was still seen as likely and
necessary. The RBA board also noted that dwelling prices in Sydney
were continuing to rise strongly which was taken by the market as
a clear sign that for the RBA to ease rates further, and risk creating
an asset price bubble, there would have to be string of sub-par
domestic economic data released to force their hand.
Australian Dollar
The AUD ended the month of June largely unchanged vs the USD,
up +0.8%. On a trade-weighted basis, the change was even less
pronounced (+0.2%).
Market expectations for
easing are setting the
stage for prolonged AUD
weakness.
Our outlook on Global REITs remains positive. In our US REIT model,
three of the five factors in the model in favour REIT’s (returns reversal,
value spread, and yield spread), the same factors that were positive
last two months as well. Although the asset class has suffered from
some underperformance due to talk about potential rate rise, we
believe the outlook for REITs is now more favourable after the recent
stabilisation in longer term interest rates and the attractive income
profile of the asset class. Fundamentally, the asset class continues
to be in high demand for investors seeking income and the current
interest rate environment should continue to be a positive for the
asset class.
3 | Economic Update - June 2015
We think the AUD will continue to face near term pressures from
depressed commodity prices, soft domestic data, and a weaker
rates outlook. Market expectations for easing are setting the stage
for prolonged AUD weakness.
Sources:
Barron’s, Bloomberg, FactSet, Morgan Stanley, JPMorgan, RBS, Credit Suisse, Citigroup,
SSGA, Performance Group, MSCI, SSgA Economics Team, SSgA ISG’s Politics and
Policy Team, TIS Group, Factset, S&P, UBS Securities Australia, BofA Merrill Lynch
Economic Update - June 2015
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4 | Economic Update - June 2015